Like two sides of the same coin, economies of scale and diseconomies of scale co-exist within a business, industry, city, state, nation and just about any kind of organization. Traditionally, scale refers to products produced on some mass level. However, scale and its respective economies or diseconomies can be achieved in families, sports, faith-based organizations or governments. Both internal and external factors affect the level of scale, while the nature of scale has evolved with new opportunities of technology and business practice.
In their most basic form, economies of scale refer to the idea that as more products are produced the marginal cost, or cost per unit, decreases because of increased efficiencies. Overhead costs can be shared over more products. Often the desire for economies of scale drives an organization to become larger or to merge with a like-minded company, which can bring additional efficiencies or opportunities. But economies of scale have their limits.
Diseconomies of scale come about when a business or organization becomes so big, or so inefficient, that the cost-per-unit of its products and services starts to rise A business can only grow so much before the benefits of growth begin to create additional costs and resources. Additional output becomes more expensive. Complexities take over and bureaucracies dominate. A good thing has turned sour. Thus, the goal for business and other organizations is to find the point of equilibrium in which economies of scale thrive and stave off the diseconomies.
Economies and diseconomies of scale are frequently broken down by the respective factors leading to a certain level of scale. Some factors are internal, while other factors come from outside the business. Internal factors such as proprietary technology, unique training methods or a certain ethos can create outstanding economies of scale, while external factors such as higher interest rates, government regulation or consumer ambivalence can create difficult diseconomies of scale.
Newer forms of economies of scale have come about with technological advances and improved business practices. The extensive dependence upon computers and the use of the Internet allow small businesses to become efficient in ways previously thought impossible. Outsourcing business functions such as payroll or customer service can be a way to achieve greater output at less cost. Cost-sharing and grouping with other membership organizations, such as a chamber of commerce, similarly allow businesses to lower their costs, offer more products and increase income.
Economies of scope and economies of scale are two different economic concepts used to help cut a company's cost. Economies of scope focuses on the average total cost of production of a variety of goods, whereas economies of scale focuses on the cost advantage that arises when there is a higher level of production of one good.
The theory of economies of scope states the average total cost of a company's production decreases when there is an increasing variety of goods produced. Economies of scope give a cost advantage to a company when it produces a complementary range of products while focusing on its core competencies. Economies of scope is an easily misunderstood concept, especially since it appears to run counter to the concepts of specialization and scale economies. One simple way to think about economies of scope is to imagine that it's cheaper for two products to share the same resource inputs (if possible) than for each of them to have separate inputs.
An easy way to illustrate economies of scope is with rail transportation. A single train can carry both passengers and freight more cheaply than having separate trains, one for passengers and another for freight. In this case, joint production reduces total input costs. (In economic terminology, this means that one input factor's net marginal benefit increases after product diversification.)
For example, company ABC is the leading desktop computer producer in the industry. Company ABC wants to increase its product line and remodels its manufacturing building to produce a variety of electronic devices, such as laptops, tablets and phones. Since the cost of operating the manufacturing building is spread out across a variety of products, the average total cost of production decreases. The costs of producing each electronic device in another building would be greater than just using a single manufacturing building to produce multiple products.
Real-world examples of economies of scope can be seen in mergers and acquisitions (M&A), newly discovered uses of resource byproducts (such as crude petroleum) and when two producers agree to share the same factors of production.
Economies of scale are reductions in average costs attributable to production volume increases. They typically are defined in relation to firms, which may seek to achieve economies of scale by becoming large or even dominant producers of a particular type of product or service. A distinction can be made between internal and external economies of scales. Internal economies of scale occur when a firm reduces costs by increasing production. External economies of scale occur when an entire industry benefits from expansion; for example, through the creation of an improved transportation system, a skilled labor force, or by sharing technology.
Economies of scope are reductions in average costs attributable to an increase in the number of goods produced. For example, fast food outlets have a lower average cost producing a multitude of goods than would separate firms producing the same goods. This occurs because the preparation of the multiple products can share storage, preparation, and customer service facilities (joint production).
According to David Kass in his 1998 article, "Economies of Scope and Home Healthcare," economies of scope exist if a firm can produce several product lines at a given output level more cheaply than a combination of separate firms each producing a single product at the same output level. Economies of scope differ from economies of scale in that a firm receives a cost advantage by producing a complementary variety of products with a concentration on a core competency. While economies of scope and scale are often positively correlated and interdependent, strictly speaking the benefits from scope have little to do with the size of output.
For instance, in the paper products industry it is common for large firms to produce their own pulp, the primary ingredient in paper, before manufacturing the paper goods themselves. However, smaller firms may have to purchase pulp from others at a higher net cost than the large companies pay. The savings from producing both pulp and paper would be an economy of scope for the large producers, although the large companies probably also have economies of scale that make it feasible to invest in pulping operations in the first place.
In another example, banks have economies of scope when they offer a variety of related financial services, such as retail banking and investment services, through a single service infrastructure (i.e., their branches, ATMs, and Internet site). Clearly, the costs of providing each service separately would be much greater than the costs of using a single infrastructure to provide multiple services.
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